Spending too much on customer acquisition? Demystifying the CAC mystery for early stage brands

By Anuradha Chandrasekaran
26 August, 2022

Do you believe that one of your company’s most important indicators has the potential to build or ruin your brand so soon? It might be able to; it might not. But if you’ve read our last post, you’ll be aware that knowing and comprehending your consumers, the various channels they use, and how to maximise their potential is more important than worrying about CAC management. Well, at least in the beginning of your growth process. Without knowing your destination, what use is it to calculate the cost of fuel?

Please note that we are not advocating against measuring CAC. We are merely requesting that you not worry about its increase and peak because every firm experiences this during the start-up and building phases. As your business expands, there are three distinct levels (Base, Peak, and Target) in the overall CAC that we also discussed.

And we did promise to fill you in on more information regarding how you should consider these various degrees of marketing performance as you begin, develop, and scale your growth engine. So let’s analyse CAC and CLTV for you right now!

The Calculation you should know 

Let’s begin by discussing how we all calculate CAC. The calculation is fairly easy.

But before you begin the build process, there are a few pitfalls you need to be aware of.

  1. First of all, there may be a LONG lead time for CAC. If you’re selling vehicles, it can take three months for someone to eventually purchase one after seeing your advertisements. It might not be telling you the appropriate story if you compare a month’s worth of marketing expenses to that month’s revenue.
  2. One of the biggest variables in the majority of D2C unit economics is CAC. Given that the industry and stage are the same, there is typically a significant difference between a company that is profitable and one that is losing money.

The easiest approach to go about developing your ideal CAC would be to conduct campaigns around these acquisition techniques, track CACs for each funnel, and experiment with a few independent client groups, new channels, communication philosophies, or pricing points that might work for your company.

As was already established, once paid promotion begins, the “early” unit economics frequently don’t make any sense at all. Most frequently, CAC exceeds gross margin (i.e., negative contribution margin after variable marketing cost). You might think that your company is unsustainable as a result. However, that is untrue!

Early-stage businesses should anticipate a high CAC because they are

Finding the right product-market match

a) Increasing brand recognition

b) enhancing their channel of acquisition

What matters is whether your CAC is moving in the direction of a sustainable goal. Let’s assume that your target CAC is $1,000 (again, this is an assumption) and that each customer costs $2,000 to acquire. You might begin to model assumptions and test acquisition methods to meet that Target CAC if your CAC is trending downward. Sadly, you won’t initially be aware of what your CAC will be. Along the way, you’ll need to make adjustments to your model and assumptions. That is why we claim that after you reach an annual run rate of $1 to $2 million, you’ll have better vision into where your CAC will land (and after talking to a lot of seasoned marketers) (Target CAC).

CAC isn’t always a terrible term, though!

As you continue your tests, your growth will defy logic: CAC rises initially (steeply if you’re ambitious), then swings downward. Your CAC declines after reaching the high because:

  1. Your brand recognition reaches a certain level.
  2. Your channels are targeted and message-optimized.
  3. Cross-channel campaigns are more successful.
  4. The quality of your goods influences word-of-mouth

Since they want to attain peak CAC as soon as possible in the build stage and determine what their sustainable/Target CAC is, most firms attempt to “leapfrog” this stage by investing a lot of money in marketing campaigns early on. Therefore, it’s crucial to keep an eye on how CAC changes over time. It’s acceptable to initially accept “unhealthy” CAC if your CAC is heading downward and stabilises after a certain point, i.e., becomes healthier over time.

Do you spend more than 40% of your budget on attracting new customers? You might want to spend more!

The majority of the businesses we speak with state that paid acquisition techniques account for 40% of the cash raised. Although the figures may be concerning, there is nothing wrong with spending so much money on acquisition for businesses that have carefully honed their development models for various channels. Large-scale, effective, and easily measurable advertising channels have been developed by Facebook and Google. Maybe they should spend even more than 40% on paid acquisition in the beginning if they can invest $100 and ultimately make back more than $100!

Among the marketing executives we spoke with, one stated, “Businesses should test friction at the margins carefully and be cautious with their money, but if a channel is successful and scalable, there’s no reason not to invest more in it. The alternative to saving money in the bank to maybe enjoy the benefits later is to not plant seeds when the opportunity is present.”

Can you discuss CAC without bringing up CLTV? Absolutely No!

Costs should be viewed as investments in a business that is developing or in its early stages. While some of these might be wise investments, others might not be very logical. However, how can you distinguish what is intelligent and what is not?

by taking a look at client lifetime value (CLTV), which is the amount of money you make from a customer over the course of their relationship with your company.

D2C brands determine how much headroom the CLTV margin allows given predicted customer acquisition expenses by using projected customer LTV (lifetime value) and projected customer acquisition expenditures (CAC). Making important assumptions is necessary for CLTV calculation. One is that they will buy from the brand on average over the course of their lifetime and at predetermined intervals. However, these estimations can vary greatly: Mattresses are replaced as infrequently as once every ten years, while razor blades are replaced frequently, footwear less so. As a result, the majority of CLTV calculations are at best speculative. Here is a straightforward formula to compute it:

Aiming for the appropriate lifetime value to CAC ratio (CLTV / CAC) is discussed in a number of papers (including our last post). However, the majority of startups lack the data necessary to calculate accurate CLTV. Most brands commonly calculate CLTV over 1, 3, or 5 years. If your company hasn’t been established that long, you can perform very straightforward calculations based on buyback or subscription renewal rates. When a company is in its early stages and has little historical data, CLTV can be difficult to comprehend. Nevertheless, you should use it as a crucial statistic to estimate your growth and supplement your grasp of CAC.

3x CLTV / Target CAC is a reasonable ratio, but excellent businesses reach 5x or higher. Additionally, it’s crucial to determine CLTV based on channel mix rather than the clients you already have, as the repeat buy rates of organic customers are frequently higher due to their steadfastness. As a result, an aggregate study cannot accurately depict a channel’s efficiency.

Your target CAC is effectively raised by a high CLTV

Business owners can increase their marketing budgets by understanding CLTV:CAC and enhancing recurring business. For instance, it can assist you in figuring out how much you can invest in attracting consumers who are likely to remain with you for a longer time and make more overall purchases.

An example of a “Target CAC” is this. Your Target CAC is the highest cost per acquisition that you consider acceptable. Additionally, if your CLTV is higher, you can defend a higher Target CAC.

Keep testing in the beginning until you understand your channel efficiency

At this stage, brands should incorporate numerous tactic sets, each with distinct CAC features, into their entire marketing approach. A superb blog, for example, might have a lower CAC than other channels, which might be highly expensive (e.g., bidding on competitor terms in Google Search). Depending on your business goals, knowing your CAC at a channel level will help you balance your spending among various marketing initiatives.

We’ll go over the many strategies you can employ at this point in our following post. Till then, pick a prudent course from the list below!

Need hypergrowth right now? Even at a higher CAC, spend everything on high-volume channels. YOLO 😉

Trying to maximise a financial runway? Obtain clients (cheaply!) with a short payback period.

In search of long-term development? Keep an eye on your CLTV:CAC ratio to attract repeat business.

We favour option C. Yet, hey! that is just us!

How do we map out that journey? Next article

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